Is Investing in Startups Always Going to be a Risky Business?

Investing in startups has always been the preserve of those with enough earnings and assets to conform to government guidelines. This was deliberately done to ensure that you would not risk your life savings on a company which you thought would be the next big thing and actually turned out to simply disappear. The rules have now changed and it is possible for anyone – regardless of their expertise in the business environment – to invest in a start up; although there remain strict rules concerning how much can be invested.

Part of the catalyst behind this change in the rules is the increased access that the average person has to the stock markets and new startups; the internet has made it theoretical possible for anyone to invest in a startup. The changes are also a result of the increasing number of startups who are no longer able to access funds through the regular channels.

Many people with good business ideas turn to family and friends; or even the person at the end of the street who they know a little. The new rules will allow them to seek sources online and even through crowd-funding with much fewer questions. It can seem like a great opportunity for people to get in on the ground floor of a new business but there are a few essential questions which should be asked before you commit your funds:

Why should you turn your attention to private funds?

The first question must be why do they need to locate funds privately? What is it about them that the banks do not like? In truth, many people are perfectly acceptable in terms of credit but the banks are unable to lend because they do not have the business experience or fit the very specific criteria they have.

The structure of the business needs to be considered carefully before you part with any funds. It is possible that an investor will seem like a business owner and may even be liable for any business debts if the business has to fold. This is not something you want to take on! It is essential to understand the business structure, your exposure and to have something drawn up in a legal document before you pass any funds over. This may seem overkill but it will protect you, your family and your assets if the worst does happen.

Profit

Even the best forecasts and an outstanding business plan are not likely to return you a quick profit. Startup businesses need all the capital they can get to simply survive the first year and then grow. It is usually essential to plough any profits back into the business for the first three to five years and there will be no profits available for anyone during this time. If you are investing a substantial amount of funds it is worth having an interest bearing agreement drawn up to ensure you receive some interest each year. Choose an investment plan with potential, and if you lack experience then ask for advice from a financial advisor.

Getting your money back

It is very difficult to get your money back from a startup. It can be years before the company can afford to pay you dividends or accessing the kind of capital it would need to reimburse you. It is important to discuss an exit strategy which will set either a time when the investment will be returned or how you can sell your stake in the business.

Do your homework

It is important to understand who you are investing in. You should confirm the background and expertise level of all the people involved in the startup. You should also have a good understanding of the industry and market sector the business is targeting and an analysis of the strengths, weaknesses, opportunities and threats for the startup. The more time the business owners have spent in preparing their business the more likely they will be to succeed.

Investing in startups doesn’t have to be that challenging. There’s always a certain amount of risk involved, but if you’re cautious, you have the highest chances to succeed. It’s all about making sensible choices and consulting with the right people!

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